- REVIEW OF FINANCIAL STUDIES Journal
- October 2010
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A large theoretical literature shows that competition reduces banks' franchise values and induces them to take more risk. Recent research contradicts this result: When banks
charge lower rates, their borrowers have an incentive to choose safer
investments, so they will in turn be safer.
However, this argument does not take into account the fact that lower
reduce the banks' revenues from performing loans.
This paper shows that when this effect is taken into account, a U-shaped
relationship between competition and the risk of
bank failure generally obtains.
- bank; risk; investment